- Asian stocks have surged this year, led by China, South Korea and India.
- HSBC says that earnings growth and multiple expansions will help power further gains next year.
- The largest downside risks lie with higher interest rates in Asia, quantitative tightening from the Fed and a return of volatility.
2017 has been a very good year for Asian stocks.
From HSBC, it shows the year-to-date returns for various markets across Asia.
With the exception of Pakistani shares, it’s been a boom time for investors, especially those in China, South Korea and India.
Reflecting just how strong a year it’s been across the region, the MSCI Asia ex-Japan index is currently up a tidy 36% year-to-date, a remarkable performance fueled by earnings upgrades, a softer US dollar, price-to-earnings expansions and firmer global growth.
The good news for investors is those themes will likely continue well into next year, at least in HSBC’s opinion, with the bank forecasting that stocks across the region will record double-digit gains again in 2018.
After the performance seen in 2017, that’s the kind of return even Die Hard’s Hans Gruber would be impressed by.
“This is driven by two key factors, changes in EPS [earnings per share] growth and changes in PE [price-to-earnings] ratios,” HSBC says.
“Earnings growth is expected to decelerate to 11.9% in the next calendar year from 22.3% currently forecast for 2017. The highest 2018 growth is, for now, expected in India, Indonesia and China.”
This table from HSBC shows current market expectations for earnings growth by individual market.
So expected earnings growth looks set to be a little lower next year, but what about potential growth in PE multiples?
On that front, HSBC says there’s still room for a small expansion.
“PEs are expected to be only moderately higher at the end of 2018 than they are now,” it says.
“Putting the EPS numbers and views on PEs together allows us to come to an initial estimate of what happens with Asian equities in 2018.
“It suggests low double-digit EPS growth can be accompanied by some moderate PE re-rating, allowing Asian equities to move around 15% higher in 2018.”
15% — happy days.
However, as most already know, forecasting can be fraught with danger, and past performance is not indicative of future returns.
HSBC is acutely aware of this fact, attaching a variety of caveats on its bullish call.
In particular, it says the most obvious downside risks lie with the prospect of interest rate hikes in Asia, the reduction in the size of the Fed’s balance sheet and, as a consequence of both, the potential return of volatility.
“In 2018, the strength of economies globally — and China’s, in particular — could increase the risk of rate increases in China and elsewhere in the region,” HSBC says.
“This is not our house view, but a risk the market might respond to nonetheless.
“Higher rates can hurt equities’ performance. Still, as long as this is set against a background of strong earnings and earnings upgrades, it should not derail the equities market.”
And, after all the talk of the Fed’s balance sheet reduction in 2017, HSBC says another risk stems from what will actually happen once that unwind begins.
“While in 2017 it was all talk about unwinding balance sheets, in 2018 we get to learn how that will actually impact markets when the actual unwinding starts,” it says.
The Fed has provided clarity and details on the programme’s implementation. This is why HSBC’s global FI team believes the execution of it will not unsettle the US Treasury market. But we can’t say the same is true for other asset classes once the QE unwinding programme gets under way.”
As HSBC rightly points out, it has never been done before, “so we are clearly entering uncharted territory”.
“We know the Federal Reserve’s QE programme was created to encourage risk-taking and drive real economic activities. Instead, financial market participants have being adding riskier instruments to their portfolios because of the withdrawal of risk-free Treasuries and lower-risk mortgage securities from the marketplace.”
Another consequence of QE was the sharp reduction in financial market volatility. Now that the Fed is starting quantitative tightening, HSBC says there’s a clear risk that volatility will increase.
“Dilip Shahani, HSBC’s Asia credit strategist, points out that this decline in volatility encouraged the use of leverage to enhance total returns in Asian credit,” it says.
“Unwinding the QE programme might inadvertently push up the volatility of non-Treasury financial assets, which could force investors to deleverage and, argues Dilip, move back up the credit rating curve.
“By extension, this could introduce more volatility to Asian equities.”
So plenty of caveats attached, and understandably so as we’re entering an era of central bank policy never seen before.
However, even with the risks, HSBC still thinks there’s plenty of fuel in the tank to propel stocks even higher.
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